Markets and Prices
Supplementary resources for high school students
Definitions and Basics
Efficiency, Supply and Demand, and Market Clearing, by Arnold Kling
Supply and Demand: Prices play a central role in the efficiency story. Producers and consumers rely on prices as signals of the cost of making substitution decisions at the margin. How are prices determined?
Economic theory says that the price of something will tend toward a point where the quantity demanded is equal to the quantity supplied. This price is known as the market-clearing price, because it “clears away” any excess supply or excess demand.
Market clearing is based on the famous law of supply and demand. As the price of a good goes up, consumers demand less of it and more supply enters the market. If the price is too high, the supply will be greater than demand, and producers will be stuck with the excess. Conversely, as the price of a good goes down, consumers demand more of it and less supply enters the market. If the price is too low, demand will exceed supply, and some consumers will be unable to obtain as much as they would like at that price—we say that supply is rationed….
Supply, from the Concise Encyclopedia of Economics
Markets in which prices can move freely are always in equilibrium or moving toward it. For example, if the market for a good is already in equilibrium and producers raise prices, consumers will buy fewer units than they did in equilibrium, and fewer units than producers have available for sale. In that case producers have two choices. They can reduce price until supply and demand return to the old equilibrium, or they can cut production until supply falls to the lower number of units demanded at the higher price. But they cannot keep the price high and sell as many units as they did before….
Microeconomics, from the Concise Encyclopedia of Economics
Until the so-called Keynesian revolution of the late thirties and forties, the two main parts of economic theory were typically labeled monetary theory and price theory. Today, the corresponding dichotomy is between macroeconomics and microeconomics….
The strength of microeconomics comes from the simplicity of its underlying structure and its close touch with the real world. In a nutshell, microeconomics has to do with supply and demand, and with the way they interact in various markets.
“Where Do Prices Come From?” by Russ Roberts at Econlib, June 4, 2007.
Prices adjust to equate how much people want to buy with how much they want to sell.
And if people want to buy more than they did before, prices rise. If people want to sell more than they did before, prices fall.
Supply and demand. Buyers are competing with each other. Sellers are competing with each other.
The prices we observe emerge from this competition.
The Basics of Demand and Supply: Although a complete discussion of demand and supply curves has to consider a number of complexities and qualifications, the essential notions behind these curves are straightforward. The demand curve is based on the observation that the lower the price of a product, the more of it people will demand. There may be occasional exceptions to this behavior (and indeed economists have developed the theoretical possibility of such an exception), but they are so few and transient that economists refer to the negative relationship between price and quantity demanded as the “law of demand.” Because of the law of demand, demand curves (such as D in the figure) are always shown as downward sloping, with the price on the vertical axis and the quantity demanded (over some period) on the horizontal axis.
The basic notion behind the supply curve is that the higher the price of a product, the more of it producers will supply. In other words, as with the curve S in the figure, supply curves are upward sloping. A justification for this upward-sloping relationship between price and quantity supplied is that the cost of producing additional units of the product increases as more is produced. So it takes a higher price to motivate additional output. But this is not necessarily the case when there is time for new firms to enter an industry, or for existing firms to expand their plant size. Such long-run adjustments to a higher price can permit more of the product to be made available at the original cost (or even a lower cost), in which case the supply is horizontal (or negatively sloped). But over periods of time that can extend to several months or more, it is reasonable to assume that supply curves slope upward….
Everything Has Its Price (And That’s a Good Thing) at LearnLiberty.
In the News and Examples
McKenzie on Prices. EconTalk podcast episode, June 23, 2008.
Richard McKenzie of the University California, Irvine and the author of Why Popcorn Costs So Much at the Movies and Other Pricing Puzzles, talks with EconTalk host Russ Roberts about a wide range of pricing puzzles. They discuss why Southern California experiences frequent water crises, why price falls after Christmas, why popcorn seems so expensive at the movies, and the economics of price discrimination.
Robert Frank on Economics Education and the Economic Naturalist. EconTalk podcast episode, October 15, 2007.
Author Robert Frank of Cornell University talks about economic education and his recent book, The Economic Naturalist. Frank argues that the traditional way of teaching economics via graphs and equations often fails to make any impression on students. In this conversation with host Russ Roberts, Frank outlines an alternative approach from his new book, where students find interesting questions and enigmas from everyday life. They then try to explain them using the economic way of thinking. Frank and Roberts discuss a number of the enigmas and speculate on the future of economics and education. The topics discussed include tuxedos vs. wedding dresses, the level of civility (or lack thereof) in New York City, the difference between vending machines for soda and newspapers, the tragedy of the commons, and the economics of love.
Ticket Prices and Scalping. EconTalk podcast episode, July 16, 2007.
EconTalk host Russ Roberts talks about scalping and visits AT&T Park hours before Major League Baseball’s All-Star Game to talk with a scalper, a merchandiser, a fan, and the police about prices, tickets, baseball and the law.
Cole on the Market for New Cars. EconTalk podcast episode, June 9, 2008.
Steve Cole, the Sales Manager at Ourisman Honda of Laurel in Laurel, Maryland talks with EconTalk host Russ Roberts about the strange world of new car pricing. They talk about dealer markup, the role of information and the internet in bringing prices down, why haggling persists, how sales people are compensated, and the gray areas of buyer and seller integrity.
A Little History: Primary Sources and References
Alfred Marshall, biography from the Concise Encyclopedia of Economics
Alfred Marshall was the dominant figure in British economics (itself dominant in world economics) from about 1890 until his death in 1924. His specialty was microeconomics—the study of individual markets and industries, as opposed to the study of the whole economy. His most important book was Principles of Economics. In it Marshall emphasized that the price and output of a good are determined by both supply and demand: the two curves are like scissor blades that intersect at equilibrium. Modern economists trying to understand why the price of a good changes still start by looking for factors that may have shifted demand or supply. They owe this approach to Marshall….
Equilibrium of Normal Demand and Supply, by Alfred Marshall. Book V, Chapter 3 in Principles of Economics
We have next to inquire what causes govern supply prices, that is prices which dealers are willing to accept for different amounts….
When demand and supply are in stable equilibrium, if any accident should move the scale of production from its equilibrium position, there will be instantly brought into play forces tending to push it back to that position; just as, if a stone hanging by a string is displaced from its equilibrium position, the force of gravity will at once tend to bring it back to its equilibrium position. The movements of the scale of production about its position of equilibrium will be of a somewhat similar kind*19. [par. V.III.21. See footnote 19 for the original diagram of supply and demand.]
Classroom experiments with supply, demand, and equilibrium.
Vernon Smith on Markets and Experimental Economics. EconTalk podcast episode, May 21, 2007. Includes printable Listening Guide.
Vernon Smith, Professor of Economics at George Mason University and the 2002 Nobel Laureate in Economics, talks about experimental economics, markets, risk, behavioral economics and the evolution of his career.